As an investor in Australia or New Zealand, there might not be any concept as confusing as dividend franking. Franked returns on shares are usually paid to shareholders annually, and most times, they don’t understand it.
You may have heard of it from friends and fellow investors or even received some yourself without knowledge of it. Or maybe you want a complete understanding before you invest.
Whichever it is, you’re in the right place. We’ll break down the concept of dividend franking in a way that you are sure to understand.
What Is Dividend Franking?
Before a company pays out returns on its shares, its profits are taxed by the government. In Australia, that would be the work of the Australian Tax Office.
After taxation, the money is paid out to investors, but they are considered income. As such, the shareholders are required to pay income tax on them.
In this system, the returns are taxed twice — with the company and then the shareholders.
However, in 1987, Australia was the first to introduce this system of dividend franking. It was created to prevent double taxation of company profits.
How Does Dividend Franking Work?
When you receive franked returns, the company has paid its tax completely. And to prevent double taxation on that income, a few things happen.
- Credits Are Attached: Franked returns on shares will come with imputation credits. This stands for the amount of tax that the company paid on your returns.
- The Shareholder’s Tax Is Calculated: When calculating your income tax on the returns, you should include the value of the franking credits. That value signifies your actual returns value pre-tax.
- The Shareholder Receives A Tax Credit: Usually, individual income tax is lower than what companies are required to pay. Thanks to that, you can use your franking credits to offset your total income tax.
- The Shareholder Might Receive A Tax Refund: If your total income tax is lower than the value of credits, then the tax office will refund the difference to you.
You can see the value of this system to investors. Your franked returns can get you tax refunds.
Fully Franked, Partially Franked, And Unfranked Dividends: What Are Those?
This is another confusing concept in the world of dividend franking, but we’ve got that too.
Companies may incur losses or carry forward previous losses in the financial year. When that happens, their tax rate lowers. As a result, they may send out returns that have part of the tax paid or none at all. Those are partially-franked and unfranked, respectively.
These usually come in percentages. A 50% partially-franked return means the company paid their 30% tax on one half and didn’t pay on the other.
With Australia having one of the highest dividend yields globally, the credits are substantial. And this system has benefited not only the investors but also the entire market by increasing competition.
So there you have it. This is a quick guide on dividend franking. See you soon.